Economics, Politics, and Ethics for the Ursuline Girl

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Perverse Incentives in Medicare

Incentives can be helpful for a business because they utilize the fact that most people act to better themselves. However, when incentives are not well thought out, they can do the opposite of what they were intended to do. These are called perverse incentives, “which are the inadvertent incentives that can be created when we set out to do something completely different.”[1] Sometimes, this is referred to as the cobra effect because during the British colonization of India, the British government “offered a bounty to be paid for every dead cobra brought to the administration officials” in order to reduce the amount of snakes in the area.[2] However, this led to people breeding cobras to receive money from them. When the government discovered this, they stopped the bounty, which lead to the cobra breeders releasing the snakes, resulting in a perverse incentive.

There are many perverse incentives in today’s economy. An important example of this is that doctors, under the Medicare Act, are given a higher reimbursement if they use more expensive drugs, like anesthesia, during a surgery. The doctors are “compensated the current sales price of a drug, plus 6%”, incentivizing doctors to treat patients that use Medicare.[3] Since “individuals act to make themselves as well off as possible,” this led to doctors using more expensive drugs in order to make more money from each procedure.[4] For example, “if doctors use a $13,000 drug, as opposed to a $3,000 drug [that does the same thing], they will be reimbursed more” because of the 6% of the cost of the drug they are receiving on top of the reimbursement fee.[5] While this incentive was meant to help doctors and Medicare patients, it is hurting those who pay taxes for Medicare. With the doctors using the most expensive medications, it is raising the taxes that citizens must pay. This is considered a perverse incentive because doctors are helping only themselves, at the expense of others.

A solution to this problem would be for the government to give the doctors a flat rate plus reimbursement for each medication, so it removes the incentive to use a more expensive prescription. Another solution would be to give the doctors a fixed fee for each procedure they complete, incentivizing the doctors to use a cheaper medication. This would bring down the Medicare tax that citizens must pay while still giving the doctors incentive to treat Medicare patients. While incentives can be used to help the market, some incentives “fail to anticipate how rational individuals might change their behavior to avoid being penalized,” and become perverse incentives, much like today’s Medicare act.[6]